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Thats technically true isn't it. Visual Novels can be video games in some cases but in others can't be video games. It really depends on the player interactivity possible.
This is really an issue with the genre name itself which allows for this sort of confusion. I think "Interactive Visual Novels" would be enough to differentiate them from regular Visual Novels.

In those cases, being called Visual Novels is misleading because you are applying a genre to some media that doesn't necessarily count as video games. Visual Novels are known as games because you can interact with the story, changing the story as a direct result. Some VN's do this in different ways by giving you an inventory but the basic idea is the same.
Really for games that are essentially Virtual Comic Books (or whatever you wish to call them) cannot count as games because of the lack of player interactivity with the games story. Its a shame that many treat them as Visual Novels when it only serves to mislead people.

Huh, now I'm getting a kind of S.T.A.L.K.E.R. vibe when you mention "the zone". Pretty damn cool game in my honest opinion. Other than that, it looks like you have nailed down well the basic premise of your story. Combining Black Box's plot with the scenario described in Long Term Studies confuses me a bit however. Can you elaborate?

Personally I liked "Long Term Studies" the most. I can imagine it would have some really great visuals and interactions between the aliens and the humans. Kinda reminds me of that movie District 9 actually. It depends on the theme of the story you are going for as well. Is it about the humans, the aliens, or both? Is it a crapsack world with dying technology? Are you trying to show the adverse affects of alien technology on human civilization? Lots of possibilities here.
Black Box is a close second for me.

This really is an interesting discussion. What is a game, Genre distinction and dissonance, definitions and subjectivity.
It all comes back the intrinsic rulesets that can be found in all video games. It requires interactivity as a direct result that conflict the purposes of the player to proceed and the game holding them back in some way.
Visual novels are a unique case, but can still be considered video games. The reason for that is that many have direct consequences for your actions that affect the story in ways a regular novel would not be able to accomplish. Simply flipping pages in a VN isn't enough to qualify it as a game. In those games, you are attempting to get the best endings, best relationships, etc that you can get. That is a competition between the player that is attempting to progress in the game the best way possible and the game that holds them back.

I've been thinking about the ending.
At some point, the brother comes back to find James if he isn't already with him. What the Cosmic Horror will do at the end of the story is show the protagonist what he is capable of by taking James. "I took him. He's inside." (just an idea of what it is capable of) The protagonist will throughout the game be making an effort to cause the obelisk to reveal itself unintentionally by learning more about the events at the college in the past , causing it to become more interested in the protagonist as a direct result. Sometime towards the end of this James will be taken.
I know the best way to end the story is to leave the story with several open ended questions based upon the events of the game, but it came to mind this may come across to the player as a cliffhanger.
How can I avoid this? Ideas for the ending are also appreciated.

Those characters you posted aren't really character descriptions. They are better attributed to "rank" , "title" , "profession" and in some cases simple relation to another person. A little more detail on the characters themselves would help once you get that bit of the story straightened out.
As for the bosses, I'm not sure you want to change their names but KFC is a little bit silly. Its your game though so go for it, maybe you plan on having a light comedy/rpg type of game.
As for the story itself, I would have to wonder why you, the player, are in a medieval tournament in the first place; I would also wonder what else is going on in this game related to the bosses and the time travel thing you seem to have going on (Medieval to futuristic).

If the rules and methods in a video game simply exist, implying that they hold no interaction with the player, then by definition they cannot be considered to be rules because they are meant to create a "game state" where gameplay is formed for the player to interact with on a digital medium.
I tend to see video games as a technological extension of the oldest physical games that have existed in history because they all have to have rules and methods to those rules in order to create gameplay. I just call it conflict because the game is working against you in some way. You have to work with what its given you and do your best to proceed in the game. That conflict is what drives the gameplay. I don't like to use the word "challenge" because a lot of people have come to think of it as difficulty.
On that note, I don't think a game requires a story to be a video game. It certainly can help, but ultimately it is the underlying rules and methods that make it a video game. A story without gameplay is simply literature or a graphic novel, etc and wouldn't apply.

Many older games tended to have this and just relied on the player making up the story for themselves. If your game doesn't have a story, then set up the game with absolutely no context into what is happening.

Its isn't wrong to call it a "Virtual Simulation" or "Art Game" as Jim Sterling would put it (look him up, hes great). Its just another way of doing a virtual experience of some description.
Minecraft is a video game for a number of reasons. In creative mode I guess you can make the argument that it is a virtual simulation of the creative process. Survival on the other hand has you fight against the mechanics the game throws at you such as: Hunger, Death, Inventory management and loss, ultimately survival.
That conflict between the game and yourself is the core of what makes it a "Game". Without any rules or mechanics it is simply a Virtual Simulation (which isn't a bad thing).

Any "game" that has ever existed has some kind of conflict within it, otherwise it isn't a game. It is a virtual competition between you, the player, and the game's mechanics that you work against. Whether that takes the form of a failure state, puzzle, or some other type of challenge varies all the time.
It is a virtual simulation if it allows for a complete experience of the entire game with 0% effort.

In this story I want some interaction and Dialogue to exist between the Cosmic Horror and the main character by proxy. Its intentions I'm going to make sure are not fully understood in the few instances it does talk to the main character.
It will be shown to be very interested in the concept of knowledge and to a lesser extent humanity, but ultimately disregard them as insignificant in relation to its own desires to escape its own dimension into ours.

Yeah I need a bit more on the cosmic horror itself. Perhaps its like this: The obelisk is a mirror to a separate dimension that is populated by a formless being. The obelisk is a manifestation of its attempts to escape into our dimension.
I'm thinking that perhaps its power is steadily growing over time and has the ability to erase the existence of those that come in contact with it. The main character over the course of the story will slowly realize this and attempt to destroy it, ending in failure as part of the beings plan to show one human being what is to come for the fate of the earth.
I don't know if this is the best way to do it, but after many revisions this is what it came down to.